May 20, 2009

There were absolute declines in the number of births in 13 of the 50 US states, including some of the poorest, such as Louisiana and Mississippi, while North Dakota, which showed strong economic growth due to an oil boom, had the biggest increase in births.

High house prices, which peaked in 2006, may have also played a role in discouraging couples from having more children.

And more recently, there is evidence that immigration into the US has dropped sharply, further lowering the population growth rate.

Kids are "expensive", we hear these days. Most couples, the great majority, think twice about having a child. Many people choose not to have children, or not to have another child, because they cannot afford it.

We have focused in our national debate quite well on the general direction for our economy, such as a green technology future. But if the number of new families with kids decreases sharply, what effect will that have on our future economy?

If technology alone could drive an economy well regardless of the birthrate, one must wonder why the Japanese economy gradually fell behind the world during a period of growth in demand for Japanese exports. There are several factors, but the striking fact right now is how domestic Japanese demand for its own products is relatively weak due to an ageing population, and this lack of demand weakens the Japanese economy.

Not only are older Japanese naturally more conservative spenders than younger Japanese, but also there are fewer young Japanese to compete for Japanese investment capital, which causes the rate of return on domestic investments to be lower than it would be with a larger young population competing for that investment capital.

Having a dearth of young people weakens an economy directly through less domestic demand, but also forces an economy to either shrink or rely on increasing exports. Exports are an uncertain foundation for an economy though, as we currently are witnessing.

We are not talking here of simply a flat population. The Japanese population will shrink, as the low birthrate of recent times plays out. The same fate could begin it's first initial undramatic step right now here in America, even while it is obscured by the recent surge in births. What decisions are couples making now? Having babies has been popular in recent years, and this could change now that money seems tight.

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What if raising kids in America was more affordable?

A few months ago after reading a post on Hedera's Corner, I calculated the increase in a family budget needed to raise 2 kids, in a detailed manner similar to the recent blog post here, where I try to be more realistic and specific than typical policy analysts. I considered what a median family could manage, with frugal choices, and arrived at a number of about $200/month extra costs during early childhood, without daycare expenses.

By my calculations, the bare minimum amount of budget help a median family would need to help them afford to raise 2 kids corresponds to a federal income tax exemption allowance of about $8000/child. For instance, if the stay-at-home mom takes a part time job after a few years, what part of the income should get taxed away? This depends on such tax detail as the exemption per dependant amount. Some could argue reasonably for more than only the $200/month extra I chose as a target increase in spending for raising 2 kids. But families typically adjust in several ways in order to afford to raise their kids -- some types of spending disappear while new types arise -- a tax break is only one piece of the picture. But it is an important piece.

"Perhaps the real way to best help families with kids is raise the federal 1040 exemption for dependents from $3500 to something more realistic like about $9000 for 1 kid, and $8000/each for more...." (my comment here)

Tom: "This blew me away folks. The personal exemption on the tax form around World War II was $624 big dollars.... Now it's $3650.... You figure out that the World War II adjusted exemption should be $8000 [adjusted for inflation]. So a family with 2 kids is a $16,000 benefit which comes out roughly to around $240/week.... Essentially we could feed 2 kids in most American homes just if we got the personal exemption back to where it ought to be."

David: "The reason Japan had a lost decade is not only because their banks had a problem....their workforce has been shrinking."

By the way, this entire interview is excellent and will be in the best-of-the-month.

Now, "$240/week" (from the interview) isn't the correct result -- the actual take-home income increase from $16,000 more in exemptions at a 15% marginal federal rate (typical family rate) is $200/month, not $240/week. (Even at a much richer marginal tax rate of 25%, this result is only $330/month).

But $200/month is enough to significantly reduce the strain of feeding and clothing 2 kids, for a frugal family, as I calculated it with specific, realistic numbers. $200/month is not enough to stop being frugal. They'll need to be more frugal than they were just before they had kids -- they'll have to change spending priorities -- but that's normal.

An even better way to make having children financially feasible though would be to raise the amount of the Child Tax Credit (CTC) from the current $1000/child to $2200/child, and also make it "fully refundable" (paid fully even if a family's income taxes for the year are less than the $2200*number of children). If fully refundable, the credit would help better in real world situations. For instance, a family with significant medical expenses which lowers their taxable income drastically could lose some part of a $2200/child CTC due simply to the fact the current CTC requires the household have total income taxes after deductions that are greater than the credit in order to receive the full credit. But a family undergoing a medical crisis (and thus with significantly reduced taxable income after medial deductions) needs more tax help to keep their children clothed and fed, not less tax refund.

Readers may recall I pointed out how and why the Japanese had trouble recovering from their financial bubble, which included the decisive fact of not enough domestic demand from young Japanese people for Japanese products. Further, this implies older Japanese people will need overseas investments to have a chance to maintain income as the nation ages since the domestic Japanese economy will shrink due to demographics alone.

So...a nation normally needs enough young people to sustain its older people in retirement. Intuitively, we can understand a nation would need at least a roughly stable population to help avoid the strain of too many retirees per worker, or... otherwise they must have drastic savings and overseas investment. The latter is exactly the response the Japanese people worked out. The personal savings rate in Japan has been huge in recent decades, above 16% at times (but the total savings rate of the Japanese economy now shows a falling trend even separately from recent deficit spending, as more and more workers retire and begin to draw on their savings.)

In America our savings rate has been much less --we are relying on having enough young people, enough workers per retiree, to help in part to sustain retirement for our older people via transfer payments -- taxes on workers to help fund Social Security benefits.

But here's where a problem arises.

If our birthrate declines from this recession, while our savings rate increases, our level of demand in the nation will continue to decline. Retirement will then face a triple hit -- fewer young workers to fund Social Security, less domestic demand to drive the economy and create profits (on investment), and finally less competition for investment capital itself, further lowering returns on retirement investments.

America has had a growing population mostly due to immigration from Mexico.

Now the recession has slowed that trend, and also is likely to make Americans newly reluctant to have kids, which they feel they would have trouble being able to afford.

The projected trend in future U.S. population is likely to reverse unless the economy turns up better than expected over next few years. It's like a tipping point. As having kids remains expensive, and retirement looks less certain, families of productive age pull back further and have fewer kids. The U.S. could change onto a path for a much lower future population than previously expected, and if the change is dramatic the negative effects would be dramatic.

The concern isn't a flat population -- there are virtues in that situation. The concern is having a sharply falling population in 20 years.

This change isn't inevitable. We could simply instead change tax policy, and alter our economic future in the most profound way.

We can help solve this very serious problem by simply returning the Federal Income Tax Personal Exemption back to roughly its inflation-adjusted WWII value. Nothing more extraordinary than adjusting for 64 years of inflation, and then rounding up the number some to $8000 (or alternatively enacting a $1200 increase in the Child Tax Credit to $2200/child).

Households across the nation of child-bearing age could then easily see that having kids becomes feasible in their budgets.

Economics matter.

If this seems interesting, you'll find more interesting stuff -- economics yes, but a lot of insight that is more broad and far-reaching than economics -- in the book I'm working on. I will be providing links here for it when it is finished. The book has some new insights into the situation we face now, not available in other books, but it's more than a book about 2008 or 2010. I'm aiming for this book to be meaningful in 2020, or 2040.